CHAPTER 12

1
Content
Definition and the functions of money
Types of money supply
Factors that influence the money supply
Participants in the money supply
process in the context of Malaysia
The relationship between money supply,
interest rates and foreign exchange with
the Malaysian economy as a whole

2
Introduction
Money is created for the purpose of
exchange
Previously, there was a barter system
Money plays an important role in the
economy because its quantity and credit
ability will affect the level of production
and the prices of goods and services
The demand and supply on the money
will determine its price or interest rates
that are fixed by BNM
3
Definition of Money
Money can be observed as:
an instrument to pay
An instrument to determine the value
An instrument to keep/save purchasing power
The acceptance of money is based on the
confidence of others to accept it
Three types of money:
Coins
Paper money
Demand deposit (current account)
4
Functions of Money
As a medium of exchange
The transfer of goods and services from
providers to consumers
The money must be accepted and received
the confidence of the community
Should be able to be divided and hard to
copy
5
To determine the value and as a
calculation unit
To value goods and services in terms of
prices, and based on the prices, comparison
can be made between goods or services
Transactions can be done easily because
the transactions can be recorded with the
value agreed
6
Functions of Money
To keep value
Can be used at any times
The most liquid instrument
To determine the value of deferred
payment
Enables people to purchase now but make
the payment later
7
Functions of Money
Bank Negara Malaysia as the
Financial Intermediary
Bank Negara two types of money known as
M2 and M3.
M2 = M1 +
Private sector saving deposits with commercial
banks and Islamic banks
Private sector matured fixed deposits with
commercial banks and Islamic banks
Negotiable certificate of deposits issued by
commercial banks to the private sector
Repo transactions conducted by commercial
banks

8
M3 = M2 +
Private sector saving deposits with finance
company, merchant bank/investment banks,
discount houses
Private sector fixed deposits with finance
company, merchant bank, discount houses
Net negotiable certificate of deposits issued
by finance company, merchant bank,
discount houses to the private sector
Repo transactions conducted by finance
company, merchant bank, discount houses

9
Bank Negara Malaysia as the
Financial Intermediary
BNM uses the M3 as the focus of money
supply influence for the purpose of
monetary management
The monetary aggregate (M3) used is
based on the belief that there is a stable
relationship between:
Monetary instrument and monetary
aggregate
Monetary aggregate and the final objective
intended by BNM
10
Bank Negara Malaysia as the
Financial Intermediary
The Demand for Money
What are the three motives for holding
money according to keynes's theory of
money demand?
1. Transaction motives:
To make payments or purchases
2. Precautionary motives:
To meet unforseen contingencies
3. Speculative motives:
It being the safest asset in wealth portfolio.
Other assets possess uncertainty and no
liquidity.

11
Factors that Influence the
Money Supply
Factors that influence the money supply
include:
Loans offered by BNM and the banking
system (commercial banks, finance
company, merchant banks, Islamic banks
and discount houses)
Overall condition of a countrys balance of
international payment and receipt
Other factors
12
Governments actions
The ability of banks to give loans depends on
banks reserves
The issuance of government debt instruments
Loans given by the Government to the banking
system
Balance of Payment
Deficit or surplus
In a surplus condition, the receipt of foreign
currencies would add to deposits in a country,
which will increase the money supply and vice
versa
13
Factors that Influence the
Money Supply
Participants
Bank Negara Malaysia on behalf of the
Government
Banking system
14
Relationship between Money
Supply, Interest Rates and
Exchange Rates
Let say the government decides to
increase the level of money supply to
reduce unemployment.
Higher money supply leads to higher price
level and a lower expected future
exchange rate
The rise in the money supply causes the
domestic interest rate to fall
Conclusion: a higher domestic money
supply causes the domestic currency to
depreciate

15